Shares of Roku Inc (NASDAQ:ROKU) have been on fire since first going public on Sept. 28 at $14-per-share. The first day of trading saw Roku stock gain $9.50, or 67%, closing at $23.50. ROKU then ripped higher after the first earnings report, trading all the way up to $48.80 yesterday before ultimately collapsing.
It was a classic case of too far, too fast for Roku stock. I’d expect the stock to have trouble heading appreciably higher over the next month.
While the price history of ROKU is certainly limited, much can still be gleaned from taking a look at the chart. The hyperbolic rise following earnings smacks of a classic short squeeze, especially given the small float and high short interest. The price action from yesterday, with ROKU making a new all time high at $48.80 only to reverse course and close near the low of the day at $36.95, is a textbook key reversal day.
The momentum is broken and the highs are in for Roku stock.
The impetus behind the reversal was likely a note from Oppenheimer downgrading ROKU based on valuation. Analyst Jason Helfstein lowered his rating on the company to underperform from perform with a $28 price target. He also stated he felt the company was the most expensive publicly traded internet-based company and that the stock was trading on non-fundamental factors.
Hopefully this is a lesson learned for all the momentum traders who blindly follow price action and ultimately valuation does matter.
So now that Roku stock looks to have made a significant blow off top at the $48 area, selling call spreads at this level seems to make intuitive sense. Roku options carry an enormously high level of implied volatility (IV) and rightfully so given the volatility in the stock. IV is well over 100%, so option prices are extremely expensive, meaning you can position further out of the money-and have a bigger safety cushion- for the same net credit.
Roku Trade Idea
Buy the ROKU Dec $50 calls and sell the ROKU Dec $48 calls for a 25 cents net credit
Maximum gain on the trade is $25-per-spread with maximum risk of $175-per-spread. Return on risk is 14.28%. The short $48 strike is positioned near the all time intra-day high of ROKU and it provides nearly a 30% upside cushion to the $36.95 closing price of ROKU.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at timbiggam@gmail.com.
